Types of mutual funds explained

Mutual funds are pooled investment vehicles that diversify their assets across stocks, bonds, and other asset classes. They are classified into different categories based on their underlying securities. As a result, there is a unique risk and return level for each fund.

There are three main fund categories based on the underlying asset classes and securities: equity, debt, and hybrid funds. Furthermore, there are two broad categories based on the investment philosophy: active and passive.

While the variety is immense, it allows an investor to find the right fund for them. To help you make a good start in mutual funds, we'll guide you through the major types of mutual funds.

What are the different types of mutual funds?

Mutual funds come in various types, each designed to meet specific investment goals and risk preferences. Understanding these classifications is key to selecting the right mutual fund for your portfolio. Broadly, mutual fund types can be classified based on:

Asset class: The type of assets the fund invests in, such as equity (stocks), debt (bonds), or a mix of both.
Fund management style: The approach used by fund managers to select investments, either active or passive.

What are the main asset class-based mutual fund types?

Mutual funds can be categorized by the types of assets they invest in. Here are the primary categories:

Equity mutual funds

These funds invest in stocks and are designed for investors looking for higher returns over the long term. However, they come with higher risks due to the volatility of the stock market. Equity mutual funds are suitable for investors who have a higher risk tolerance and a long investment horizon.

• Large-cap funds: These funds invest primarily in large-cap companies, which are defined by SEBI as the top 100 companies in terms of full market capitalization. By regulation, large-cap funds must allocate at least 80 per cent of their assets to these companies. These are typically well-established, financially stable businesses with a long track record. Large-cap funds are generally considered lower-risk, offering moderate but steady returns, making them suitable for conservative or first-time equity investors.
• Mid-cap funds: Mid-cap funds invest in mid-sized companies, specifically those ranked 101st to 250th by full market capitalization as per SEBI's classification. They are required to invest at least 65 per cent of their assets in mid-cap stocks. These companies typically have higher growth potential than large-caps but are less stable, making mid-cap funds moderately high-risk with the potential for better returns over the long term.
• Small-cap funds: These funds focus on small-cap companies, i.e., those ranked 251st and below in terms of market capitalization. Small-cap funds must invest at least 65 per cent of their assets in these stocks. While these companies can deliver significant growth, they are also more vulnerable to market volatility and business uncertainties. As a result, small-cap funds carry higher risk and are suitable for investors with a high risk appetite and a long investment horizon.
• Flexi-cap funds: These funds dynamically allocate investments across large, mid, and small companies based on market conditions. Flexi-cap funds provide diversification and flexibility. Also, they do not have any mandates on their allocation across market caps.
• Multi-cap funds: These funds are mandated to invest at least 25 per cent in small-caps, mid-caps, and large-caps each. However, with a minimum of 50 per cent invested in mid-caps and small-caps, you can expect these funds to be fairly volatile.
• Sectoral thematic funds These funds focus on specific industries or themes, such as IT, pharma, or infrastructure. While they offer concentrated exposure to a particular sector, they are more susceptible to sector-specific risks.
• Dividend yield funds These funds invest in companies that regularly pay dividends.

Debt mutual funds

Debt funds invest in bonds and other fixed-income securities, providing stable returns with lower risk compared to equity funds. They are suitable for conservative investors looking for regular income or lower volatility.

• Liquid funds: These funds invest in highly liquid instruments, such as certificates of deposits, treasury bills and commercial papers, that have a maturity period of upto 91 days. Therefore, these funds are less risky. You can also park your emergency funds in liquid funds and can receive your funds relatively quickly.
• Short-duration funds: These mutual funds are mandated to maintain a Macaulay duration of one to three years. Short-duration funds mainly invest in a mix of government and corporate bonds of different varieties.
• Long-duration funds: These are mutual funds that primarily invest in long-term debt securities, such as government and corporate bonds, that have a maturity period of over 7 years. These funds aim to provide higher returns than shorter-duration funds by investing in bonds with longer time horizons. However, they are more prone to interest rate fluctuations.
• Corporate bond funds:They invest primarily in corporate bonds. These funds pool money from multiple investors to purchase a diversified portfolio of bonds issued by companies across various sectors and credit ratings.
• Gilt funds: Gilt funds are a type of mutual fund that primarily invests in government securities, such as bonds issued by the central or state government. These funds are considered low-risk investments because they are backed by the government's credit.
• Dynamic bond funds These funds shift between short- and long-term bonds based on interest rate trends. They offer the potential for higher returns but require active management.

Hybrid mutual funds

Hybrid funds combine investments in both equity and debt securities, providing a balanced approach to risk and return.

• Aggressive hybrid funds These funds have a higher equity allocation, offering greater growth potential but also higher risk.
• Conservative hybrid funds These funds allocate a larger portion to debt instruments, making them more stable but with potentially lower returns.
• Balanced advantage funds These funds dynamically adjust their equity and debt allocation based on market conditions, providing a flexible approach to balancing risk and return.
• Multi-asset funds These funds invest across a mix of asset classes, such as equity, debt, and commodities like gold - with at least 10 per cent in each. These funds provide excellent diversification, which helps manage risk.

Commodity mutual funds

• Gold Funds: Gold mutual funds in India are usually Funds of Funds (FoFs) that invest in an underlying Gold ETF. These ETFs hold physical gold of 99.5 per cent purity, stored in secured vaults and regulated by SEBI norms. The mutual fund route (FoF) is ideal for those without a demat account.
• Gold ETFs: Alternatively, Gold ETFs can be bought and sold directly on the stock exchange through a demat and trading account. They offer a more cost-efficient and transparent way to gain exposure to gold but require investors to handle execution themselves.
• Silver Funds: Just like gold, silver exposure is available via Silver ETFs, which hold physical silver of 99.9 per cent purity. Investors can access these either directly (through a DEMAT account) or via Silver FoFs (mutual funds investing in silver ETFs).

Suggested read:
Multi-asset funds 101: What you need to know
Gold ETF vs gold mutual fund: There's only one right choice!

How do mutual funds differ based on management style?

Mutual funds can also be classified based on their management style - how the fund manager selects and manages investments.

Active mutual funds

Active mutual funds are managed by professional fund managers who make decisions about buying and selling securities with the goal of outperforming the market. These funds typically involve higher fees due to the active management process, but they can offer significant returns if the fund manager makes successful investment decisions.

Passive mutual funds

Passive mutual funds, such as index funds and exchange-traded funds (ETFs), aim to replicate the performance of a specific market index like the Nifty 50 or Sensex. These funds usually have lower management fees compared to active funds. This is because there is little intervention from fund managers. They only help rebalance the portfolio based on the changes in the index it is tracking.

Suggested read: ETFs vs mutual funds: Which should you choose? | The Index Investing Revolution: Why Everyone's Talking About It

What are the different mutual fund structures?

The structure of a mutual fund depends on its ease of buying and selling. Here are the main types:

Open-ended mutual funds

Open-ended mutual funds allow investors to enter or exit the fund at any time. These funds issue new units to investors and redeem units when investors sell. Open-ended funds are the most common type of mutual fund.

Close-ended mutual funds
Close-ended funds can only be bought during the NFO period. After which, these funds remain closed off to the general public. While they are traded on the stock exchange, the liquidity is generally poor, and it can be challenging to buy and sell from there.

Interval funds

Interval funds combine features of both open-ended and close-ended funds. Investors can buy and sell units at specific intervals, offering a balance between flexibility and structure.

Can mutual funds help you save taxes?
Only one mutual fund category offers tax benefits. Let's explain the basics of it:

Equity-linked savings scheme (ELSS)

ELSS funds are equity-oriented mutual funds that offer tax benefits under Section 80C of the Income Tax Act. These funds come with a 3-year lock-in period, making them ideal for long-term investors who want to reduce their taxable income while benefiting from potential stock market growth.

Note: Section 80C benefits are available to investors opting for filing taxes under the Old Tax Regime.

How do you choose the right mutual fund type?

Choosing the right mutual fund depends on several factors, including:

• Investment goals: Are you looking to preserve your capital for a short time or create wealth over the long run? Your financial goals will guide your fund selection.
• Risk appetite: Consider how much risk you are willing to take. Higher-risk funds offer greater growth potential, but they have higher volatility, leading to an increased chance of losses.
• Time horizon: Your investment duration plays a critical role in determining the right mutual fund type. Long-term investors can take on more risk.
• Fund manager expertise: Research the track record and expertise of the fund manager, as their decisions will impact the fund's performance.
• Fees and charges: Compare the expense ratios and exit loads to ensure you're getting the best value for your investment.

Conclusion

Mutual fund types are diverse and cater to different investment objectives, risk tolerances, and time horizons. Whether you're looking for stable income, high growth, or a balanced approach, there's a mutual fund out there that fits your needs.

Start by understanding your financial goals, assessing your risk appetite, and researching the available mutual fund types. By selecting the right type of mutual fund, you can create a diversified and well-rounded portfolio that helps you achieve long-term financial success.

Also read: How to invest in mutual funds

This article was originally published on April 30, 2025.